Recently, several students from the Babson College MBA program called requesting an interview. They were researching the venture debt market and wanted an insiders view of how this segment compares with venture capital. Their questions were thoughtful and I thought the discussion was worth sharing. An excerpt from the interview appears below:

Q. How does venture lending (VL) differ from venture capital (VC) as it relates to fund- raising expenses?

A. Fund-raising expenses in connection with venture loans are generally lower than for venture capital transactions. Legal fees are one of the largest expenses in many transactions. Lenders typically negotiate venture loan arrangements using their standard documents. Venture capitalists, however, usually use newly created stock purchase agreements. These agreements add considerable expense to these transactions since outside legal counsel is used. Other VC expenses include a more expensive and comprehensive due-diligence process.

Q. What about the flexibility of agreement terms?

A. It is difficult to compare the flexibility of terms between the two forms of financing. Flexibility can vary from lender to lender and from VC to VC. Generally, venture capital is a more flexible form of financing than venture debt since the proceeds are allowed to be used for many purposes. Usually, no collateral is required and there are fewer agreement covenants than lenders require. Venture loans often limit the use of proceeds to the acquired capital assets or for specific working capital purposes. Venture lenders usually require collateral and they may incorporate several covenants and conditions into their loan agreements.

Q. Are there VL companies that focus on segments other than technology or life sciences (e.g., retail, restaurants)?

A. There are not many venture lenders that specialize outside of those areas at present. The universe of venture lenders is relatively small, particularly in comparison to the VC industry. There are probably fewer than thirty U.S. firms that specialize primarily in venture lending or leasing. Most are involved in the segments that you mentioned.

Q. How much time does it normally take to get money from a venture lender? How many visits does an entrepreneur have to make to a venture lender before a final decision is made?

A. Most venture loans take at least thirty days to complete from the point of meeting the prospect to actual funding. Completion time can range up to sixty days or more, depending on the complexity of the credit. Most lenders will meet with the prospect a few times before committing.

Q. Can an entrepreneur continue window-shopping if a venture lender has started due-diligence?

A. Yes, but lenders frown upon shopping because of the time they commit to processing the transaction. The norm in the business is to bind a transaction with a commitment letter and fee. If the borrower/lessee continues shopping and chooses another provider, the fee is usually forfeited.

Q. Ideally, at what stage would an entrepreneurial company be considered safe for venture lending (e.g., a startup seeking the first round of financing or a company that already has a first equity round and is seeking a second round)?

A. Most venture lenders get involved after the company has successfully raised at least $5 million or more from a reputable venture capital sponsor - that is, after the A round.

Q. What are collateral requirements for a growth capital loan?

A. Collateral requirements vary. Some venture loans/leases are collateral specific. The lender requires collateral in the form of the equipment being financed. Other transactions are more flexible, allowing the proceeds to be used for general growth purposes and working capital. In the latter arrangements, the lenders may require an all-asset (blanket) lien on the borrowers assets.

Q. Would venture lenders invest in a company not sponsored by VCs? Are there any exceptions?

A. Generally, venture lenders invest only in companies backed by VCs or reputable investors with future capital to commit. The reason these sponsors are needed is that the enterprise usually is not approaching the point of profitability and will require additional funding rounds. There are exceptions and it depends on the other strengths of the credit. For example, a particularly strong cash position and strong collateral can entice a lender to relax the requirement of ongoing VC support as long as the lender has confidence in the management team. Other factors may also influence the decision.

Q. What are the top four or five characteristics that you consider before deciding whether to finance a startup?

A. We look for talented and experienced senior managers, strong VC sponsorship from reputable VCs, a compelling business plan and enterprise track-record since inception, an acceptable cash position and burn-rate, and acceptable collateral quality.

Babson MBAs: Mr. Parker, thanks so much for taking time to speak to us about venture lending. Your talk has given us an opportunity to gain valuable insight into this exciting industry.

George Parker: It has been my pleasure. I hope you find this information helpful and that you will consider venture lending as you form your career plans. Good luck in your research and give me a call if you need more information.